As has been the case for the past several quarters, Terra Nitrogen Company (NYSE: TNH) continues to deal with slumping nitrogen fertilizer prices. While the company was able to offset weak prices with higher production to a certain degree, it still affected the bottom line and its ability to give cash back to investors.
After such a long slide in prices, investors are probably wondering how much longer this can last. According to the management team at Terra Nitrogen's parent company, CF Industries (NYSE:CF), it might be a while. Here's a look at Terra Nitrogen's most recent quarter and how investors should look at CF Industries' outlook for the future of the nitrogen market.
By the numbers
|Metric||Q1 2017||Q4 2016||Q1 2016|
|Earnings per unit||$2.10||$1.85||$1.44|
|Distributions per unit||$0.97||$1.22||$1.51|
Terra Nitrogen's results were mostly mixed for the quarter. The good thing from earnings was that its total volumes of ammonia and urea ammonium nitrate (UAN) rose 40% and 47%, respectively. For the increase, Terra Nitrogen can thank its entire Verdigris fertilizer facility, which was running at a high rate compared with this time last year, when the company experienced an unplanned outage at the facility.
The bad thing was that the company started selling more nitrogen fertilizers into an already well-supplied market. The average selling prices for ammonia and UAN declined by 23% and 24%, respectively. To make things worse, the average price of natural gas -- Terra Nitrogen's primary feedstock -- was up 5%. The combination of higher volumes, lower realized prices, and higher feedstock costs all pretty much offset themselves, as gross margin for the most recent quarter and the prior year's result were both 39%.
One discrepancy worth noting in these numbers is operating income and earnings-per-unit results. The reason earnings per unit for this quarter were higher but operating income was lower compared with the prior quarter is that a larger portion of the prior quarter's earnings was allocated to CF Industries. That's nothing worth writing home about.
What management had to say
Since CF Industries is the general partner and operator of Terra Nitrogen, it doesn't host a conference call. According to CF Industries CEO Tony Will, though, the market for nitrogen fertilizers still very much remains in a state of flux:
As we look at producers in high-cost regions, we are seeing rational behavior in response to these current industry conditions. For example, we have seen reductions in Ukrainian urea operating rates and recently announced curtailments of ammonia production there as well. Chinese producers have reduced operating rates and exports due to the low global price environment.
Reported Chinese operating rates for the first quarter remained below 60%. While there were roughly 9 million metric tons of capacity shut down permanently in China last year, an additional 7 million metric tons has also been idled. A majority of those plants have been idle for many months and are not currently running despite local Chinese spring demand. We believe this increases the probability that a substantial portion of these plants will not restart.
According to industry sources, Chinese urea exports were 1.2 million metric tons during the first quarter compared to 3 million metric tons during the first quarter of 2016. We continue to expect 5 million to 6 million metric tons of exports from China for the full year 2017, which is down significantly from recent years.
At the same time, the number of new capacity expansion projects being initiated around the globe has slowed dramatically. We continue to project the rate of net new capacity growth after this year and for the foreseeable future to be well below the normal annual demand growth rate of 2%. Therefore, we expect the global supply and demand balance to tighten over the next few years, leading to industry recovery.
What a Fool believes
Unlocking shale gas in the U.S. has had a profound impact on the global nitrogen fertilizer market. Cheap feedstocks have led to a surge in newly constructed facilities that have significantly lowered North America's import demand for fertilizer, and it's disrupting decades of trade flows and keeping prices incredibly low.
Terra Nitrogen has suffered its fair share from lower prices, but it remains a low-cost operator that still throws off cash to shareholders thanks to its debt-free balance sheet and variable rate distribution policy. It will probably take a while before the nitrogen fertilizer market adjusts to this new trade flow, but Terra Nitrogen has the traits to survive these tough times and will be well positioned to benefit when the market normalizes again.